Pit Inflation: Pop Goes the Premium?
For the past 3 years, the floor traders in the pits have steadily jacked up the premium on the S&P Futures Contract.
If you take the 2nd Day's Close (after rollover to the new contract) and plot it, you'll see that premium has more than doubled in the past two years. The 2nd Day's Close After Rollover makes a reasonable comparison from contract to contract (the 1st day's premium can get a bit whacky with arbitrator action). You could also plot the average price during the first week of a new contract's activity and come up with comparable results.
Premium today is twice what it was two years ago ($23.50 on the 2nd Day's Close After Rollover of the current SPZ_0 December contract vs. $11.23 on the 2nd Day's Close After Rollover of the SPZ_8 December 1998 Contract). Today's premium is over three times the size it was on the March 1998 Contract rollover.
There's a graph which shows this in a duplicate of all this at my site: sellnow.net
People working in the pits are, by and large, SUCCESSFUL traders (as opposed to daytraders, who have a very hard time achieving success ... statistics suggest that as many as 9 out 10 actually fail).
For the most part, the pit crew does not gamble. They bet on sure things. They make the market. They get paid for doing it. They run a business at a considerable profit. In their daily meanderings, charity is not their strong suit. They take no prisoners. They quickly hedge their bets when the market forces them to face risk. Bravery gets punished. A high IQ rarely matters.
The pits display survival of the fittest and the fastest. So what does it mean when these market makers increase their margin by pushing premium up to record levels?
Is the product in short supply? Hardly.
Has the intrinsic value of the product doubled or tripled? No, it has not.
The futures premium represents what the bull market will bear. The fact that it keeps rising suggests that most buyers think the bull market will continue, despite the fact that no new highs have been seen in the S&P Futures for half a year.
Does this premium inflation mean the good times will keep rolling forward? Not at all. In fact, it suggests (at least to me) that some serious downside volatility may effect the futures' future.
Premium erodes quickly when a market slides south. When the boyz and girlz in the pits have a tough time selling their product, they drop the price. They put the futures contract "On Sale" by slashing premium.
This is not a chicken and egg scenario. They will slash the premium first, and fast, because dumping the product is the easiest way for a market maker to hedge a bet.
The premium on the 2nd Day's Close After Rollover for the September 2000 contract (which expired last Friday) was $24.90. The comparable premium on the new December contract fell to $23.50, even though the S&P Cash SPX on the comparable day was actually higher than it was 3 months earlier.
Something similar happened going into the December contract in 1998 (a rollover which was followed by the October 1998 slide). Ditto 1997 (a bigger slide).
It appears that the most successful short-term traders ... the floor traders working in the pits ... are starting to hedge their bets.
It remains just one hint at the short-term future of the market. But it supports a more bearish stance right now. |
